1. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 1 Thème 5 Cost Allocation: Joint Products and Byproducts

2. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 2 Joint Cost Terminology Joint Costs – costs of a single production process that yields multiple products simultaneously, Split-off Point – the place in a joint production process where two or more products become separately identifiable, Separable Costs – all costs incurred beyond the splitoff point that are assignable to each of the now-identifiable specific products.

3. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 3 Joint Cost Terminology Categories of Joint Process Outputs: 1.Outputs with a positive sales value, 2.Outputs with a zero sales value. E.g., offshore processing of hydrocarbons yields oil and natural gas, which have positive sales value, and it also yields water, which has zero sales value and is recycled back into the ocean. Product – any output with a positive sales value, or an output that enables a firm to avoid incurring costs (e.g., an intermediate chemical product used as input in another process):  Value can be high (main or joint products) or low (byproduct).

4. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 4 Joint Cost Terminology Main Product – output of a joint production process that yields one product with a high sales value compared to the sales values of the other outputs, Joint Products – outputs of a joint production process that yields two or more products with a high sales value compared to the sales values of any other outputs.

5. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 5 Joint Cost Terminology Byproducts – outputs of a joint production process that have low sales values compare to the sales values of the other outputs.

6. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 6 Sum-Up Joint costs are costs which yield multiple products simultaneously, Split-off point is the juncture in the process when separate identifiable products emerge, Separable costs are costs incurred beyond the split-off point and are assignable to separate products. Joint Costs Product A Separable Costs A Product B Separable Costs B Split-off Point

7. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 7 Sum-up Joint products have a relatively high sales value and are not separately identifiable as individual products until the split-off point, Main product is the one with the highest sales value resulting from a process yielding two or more products, Byproducts have a low sales value relative to sales value of the main or joint products, Scrap products have a minimal (often zero) sales value. Main Products Joint Products Byproducts HighLow Sales Value

8. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 8 Joint Process Flowchart

9. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 9 Reasons for Allocating Joint Costs Required for GAAP and taxation purposes, Cost values may be used for evaluation purposes, Cost-based contracting.

10. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 10 Joint Cost Allocation Methods Physical Measures – allocate using tangible attributes of the products, such as pounds, gallons, barrels, etc. Market-Based – allocate using market- derived data (dollars): 1.Sales value at split-off, 2.Net Realizable Value (NRV), 3.Constant Gross-Margin percentage NRV.

11. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 11 Physical-Measure Method Allocates joint costs to joint products on the basis of the relative weight, volume, or other physical measure at the split-off point of total production of the products.

12. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 12 Physical Measure Method Allocate joint costs to products based on their relative proportions at the split-off point. Raw Milk $400 Cream 25 units Skim 75 units Split-off Point CreamSkimTotal Physical measure 2575100 Weighting25%75%100% Joint costs allocated$100$300$400

13. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 13 Sales Value at Split-off Method Uses the sales value of the entire production of the accounting period to calculate allocation percentage and not just the quantity sold because joint costs were incurred on all units produced, not just the portion sold during the current period.

14. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 14 CreamSkimTotal Sales value at split-off$200$300$500 Weighting40%60%100% Joint costs allocated$160$240$400 Sales Value at Split-off Method Allocate joint costs to products based on their relative value at the split-off point. Raw Milk $400 Cream $200 Skim $300 Split-off Point

15. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 15 Net Realizable Value Method Allocates joint costs to joint products on the basis of relative NRV of total production of the joint products, NRV = Final Sales Value – Separable Costs.

16. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 16 Allocate joint costs to products based on their estimated final selling prices less separable processing costs. Net Realizable Value (NRV) Method Pages 573 - 574 Raw Milk $400 Cream Split-off Point Skim Butter $500 Condensed Milk $1,100 Processing $280 Processing $520 CreamSkimTotal Final sales value$500$1,100$1,600 Separable processing costs280520800 Net realizable value220580800 Weighting27.5%72.5%100% Joint cost allocation$110$290$400

17. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 17 Constant Gross Margin NRV Method Allocates joint costs to joint products in a way that the overall gross-margin percentage is identical for the individual products, Joint Costs are calculated as a residual amount.

18. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 18 ButterCondensed CreamMilkTotal Total final sales value$1,600 Joint and separable costs1,200 Gross margin$400 Gross margin %25% Final sales value$500$1,100$1,600 Gross margin @ 25%125 275 400 Imputed total costs3758251,200 Separable costs 280 520 800 Allocated joint costs$ 95$ 305$400 Constant Gross Margin % NRV Method Allocate joint costs so that the gross margin % for each product is the same. Pages 574 - 575

19. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 19 Irrelevance of Joint Costs When considering whether to sell a product at the split- off point or process further, ignore joint costs. Raw Milk $400 Cream Split-off Point Skim Butter $500 Condensed Milk $1,100 Processing $520 Processing $280 Cream versus Butter CreamSell @ Split-offProcess Further Relevant revenue$200$500 Relevant costs 280 Incremental operating income$200$320

20. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 20 Method Selection If selling price at split-off is available, use the Sales Value at Splitoff Method, If selling price at splitoff is not available, use the NRV Method, If simplicity is the primary consideration, Physical-Measures Method or the Constant Gross-Margin Method could be used, Despite this, some firms choose not to allocate joint costs at all.

21. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 21 Sell-or-Process Further Decisions In Sell-or-Process Further decisions, joint costs are irrelevant. Joint products have been produced, and a prospective decision must be made: to sell immediately or process further and sell later, Joint Costs are sunk, Separable Costs need to be evaluated for relevance individually.

22. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 22 Sell-or-Process Further Flowchart

23. Contrôle Interne Avancé-HEC Lausanne- 2007/2008 23 Byproducts Two methods for accounting for byproducts: Production Method – recognizes byproduct inventory as it is created, and sales and costs at the time of sale, Sales Method – recognizes no byproduct inventory, and recognizes only sales at the time of sales: byproduct costs are not tracked separately.